Huaming Power EquipmentLtd (SZSE:002270) has had a rough three months with its share price down 12%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Huaming Power EquipmentLtd's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Huaming Power EquipmentLtd is:

18% = CN¥578m ÷ CN¥3.2b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every CN¥1 of its shareholder's investments, the company generates a profit of CN¥0.18.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Huaming Power EquipmentLtd's Earnings Growth And 18% ROE

To start with, Huaming Power EquipmentLtd's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 6.8%. This probably laid the ground for Huaming Power EquipmentLtd's significant 20% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared Huaming Power EquipmentLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.2% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is 002270 worth today? The intrinsic value infographic in our free research report helps visualize whether 002270 is currently mispriced by the market.

Is Huaming Power EquipmentLtd Using Its Retained Earnings Effectively?

Huaming Power EquipmentLtd has very a high three-year median payout ratio of 105% suggesting that the company's shareholders are getting paid from more than just the company's earnings. In spite of this, the company was able to grow its earnings significantly, as we saw above. With that said, it could be worth keeping an eye on the high payout ratio as that's a huge risk.

Additionally, Huaming Power EquipmentLtd has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 67% over the next three years. The fact that the company's ROE is expected to rise to 23% over the same period is explained by the drop in the payout ratio.

Summary

Overall, we feel that Huaming Power EquipmentLtd certainly does have some positive factors to consider. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.